Thursday, 3 March 2016

Official GDP data is embedded in its vision and strategy. But the numbers seem wrong.

Finance Minister Arun Jaitley presented his first two budgets amid high expectations. He was supposed to usher in bold reforms, push up investment, revive India's engines of growth and create an environment in which domestic and foreign capital felt confident of investing. The budget speech was expected to outline a roadmap for liberalising the economy. It was hoped to be more reformist than the budget speech of 1991.

Budget 2016 was presented under completely different expectations. Fingers were crossed that Jaitley would not deviate again from the path of fiscal consolidation. It was hoped that the strategy of borrowing more for public investment would not be tried again. Markets prayed that an impending rejig of the long-term capital gains tax was just a rumour.

When the budget was announced, most heaved a sigh of relief. Many bad ideas had been kept out. A few good ideas had crept in. Jaitley decided that it was more important to stick to deficit numbers. There was no mention of the long-term capital gains tax. Public spending was more or less budgeted to be under control. Whether this was done to persuade RBI Governor Raghuram Rajan to cut rates, to protect India's credit rating, or out of genuine concern about the debt-to-GDP ratio, it was a relief.

Some worry that the budget numbers are based on unrealistic assumptions, that these numbers can never be achieved. Others feel that there has been a shifting of budgetary allocation from mundane-sounding heads to more politically correct heads. Still others find that investment in roads and railways will now be done by off-balance sheet borrowing. Yet, on the whole, there is cheer.

The need of the hour is a rate cut. And for that, we needed an announcement of sticking to the path of fiscal consolidation.

It is now hoped that Rajan will cut interest rates, will cut them soon and will cut them by a significant amount. Further, it is hoped that he will ease liquidity in the banking system so that the policy rate cut is transmitted to other interest rates. Lower rates would ease the interest burden on industry and prevent further damage to balance sheets. Hopefully, it will also eventually help spur investment.

Given the poor transmission mechanism of monetary policy and the weak balance sheets of banks, hopefully Rajan will also allow the rupee to weaken. A depreciated rupee would help make imports more expensive and exports cheaper, thus giving a boost to demand for industry.

Other than the impact of the budget on boosting growth through the easing of monetary policy and a more competitive currency, there is little else in the budget that will help push investment. For example, the retrospective tax was not repealed. Only assurances about the good behaviour of the income tax department were given. Similar assurances have been made in the past. The reduction in the corporate tax rate did not take place as promised. There was little progress on disinvestment or privatisation. There was no serious cut in food or fertiliser subsidy. Rural distress and low income growth in the farm sector received significant attention in the budget speech, though, fortunately, not that much in terms of budgeted expenditure.

One explanation for why the economy does not need more reforms could lie in the GDP numbers. The logic seems to be as follows: We've already achieved high growth. GDP growth has now accelerated to 7.6 per cent. The increase in Central government capital expenditure has revived investment. The government converted the difficulties and challenges it faced when it came to power into opportunities. Make in India, Skill India, Digital India and a host of other initiatives have yielded results. We are growing faster than China or anyone else.

Mission accomplished! Now we can turn our focus away from growth to redistribution. The redistribution should be done better, with lower leakages and improved targeting. Money should go to the poor and to farmers. More taxes and more transfers can reduce distress. That is why the focus of the budget is not on reviving investment and growth.

While it is all very good if the GDP numbers could be relied upon to tell us the state of the economy, few today have faith in these numbers. Most of us, including macroeconomists like me who have spent most of their lives studying GDP numbers, no longer understand what GDP in India means. This is not to doubt the CSO's methodology in correctly measuring value-added or its sincerity in deflating it with what it believes is the correct deflator; this is more a case of complete bewilderment.

In the past, when production, profits, wages and jobs grew, GDP growth would be healthy. If production was falling, the GDP would fall. Perhaps it was all a play of a healthy inflation rate in which simple calculations made in our heads would make sense. Today, when the volume index for manufacturing is showing tepid growth, we learn that manufacturing GDP is growing very fast. When the net sales of companies are flat, we learn that wages and profits are growing. When bank credit growth is slow and banks are not lending, we are told we need to deflate them correctly and that will turn bank credit growth upside down.

Regardless of what the GDP numbers say, however much they point upwards, almost everything tells us that the economy is looking down. Focusing on GDP numbers hides the danger that we may be living in la-la land. Unless we acknowledge that there is a problem of slow growth and low investment, we do not worry about how to solve it. Perhaps that is why the budget did not focus on investment revival.

There are a few good initiatives in the budget but none that reflects the urgency of the situation. In other words, official GDP data is embedded in Jaitley's vision and strategy. If the GDP does not reflect the true state of the Indian economy today, these may need a reassessment.